Tax Incentives for the Promotion of Industrial Employment in Developing Countries 1

SO-CALLED TAX INCENTIVES are widely used, in developed as well as developing countries, to promote private investment. These measures take many forms and have been the subject of much discussion and analysis.2 But little attention has been given to their effect on employment in developing countries. I purpose to explore the feasibility of adapting these devices to increasing employment and to consider alternative measures that might achieve this goal.


SO-CALLED TAX INCENTIVES are widely used, in developed as well as developing countries, to promote private investment. These measures take many forms and have been the subject of much discussion and analysis.2 But little attention has been given to their effect on employment in developing countries. I purpose to explore the feasibility of adapting these devices to increasing employment and to consider alternative measures that might achieve this goal.

SO-CALLED TAX INCENTIVES are widely used, in developed as well as developing countries, to promote private investment. These measures take many forms and have been the subject of much discussion and analysis.2 But little attention has been given to their effect on employment in developing countries. I purpose to explore the feasibility of adapting these devices to increasing employment and to consider alternative measures that might achieve this goal.

The establishment of new industries in developing countries is usually an implicit or explicit part of a development plan that is supported by substantial public investment in infrastructure, such as harbors, high-ways, and electric power. Since these countries are in general characterized by shortages of capital and surpluses of labor, many different measures, including tax incentives, have been devised to attract private capital from abroad (as well as from within) for the formation of new industries that will employ domestic materials and labor.

Such industrialization is generally accepted as an essential part of the process by which developing nations are able to raise their standard of living and become more self-sufficient. A paramount objective by which the success of these programs is frequently judged is improvement in the balance of trade. This may be achieved through the promotion of both import-substitute industries and export industries, and in some countries different incentives are designed to achieve these different ends.

With few exceptions, capital investment rather than employment of domestic labor appears to be the overriding objective of these industrial incentive plans. This does not necessarily reflect a lack of concern for the absorption of surplus labor; in fact, many, if not most, investment laws require employment and training of local labor as a necessary condition of approval of a pioneer enterprise. Rather, it may reflect an irrational preference for technology and emulation of industrialized countries.3

Available data show that only a relatively small amount of employment is attributable directly to firms approved under tax incentive plans (Table 1). Although these data are fragmentary, the generally low ratios of employment to the potential labor force suggest that tax incentive laws cannot be expected to make more than a minimal contribution to the absorption of underemployment in developing countries. Indeed, it is questionable if many countries should look to industrialization as a solution of their unemployment problem. With reference to Asia, Myrdal concluded on this point: “… because of the low level of industrialization from which these countries begin and the rapid population increase, modern industry, even if it grows at an extremely rapid rate, cannot absorb more than a small fraction of the natural increment in the labor force for decades ahead. In the initial stages of industrialization, it may even be difficult to keep the absolute size of the labor force engaged in all types of manufacturing from falling. … This situation arises both because the direct expansionary impact of modern industrial growth on employment is likely to be slight in the early phases and because the risk of backwash on traditional manufacturing is substantial.”4 This generalization for Asian countries is true in varying degrees for developing countries in other regions of the world.5

Table 1.

Selected Countries: Capital and Employment in Approved Firms

article image
Sources: Yearbook of Statistics, Singapore, 1967; International Bank for Reconstruction and Development, Current Economic Position and Prospects of Thailand, Vol. II (Washington, 1969); Jamaica Industrial Development Corporation, Statistical Report of Manufacturing Enterprises Approved and Operating Under Industrial Incentive Laws; Trinidad and Tobago Industrial Development Corporation; Memoria del Gerente General del Banco Central del Ecuador, 1968; A. Pimental-Rodriquez, Los Incentivos Fiscales y el Desarrollo Industrial de Guatemala (University of Guatemala, 1969); United Nations Industrial Development Organization, Report on Interregional Seminar on Incentive Policies for Industrial Development (mimeographed, 1969); United Nations, Statistical Yearbook, 1968 (New York, 1969).

Midyear 1967 estimates.

Excludes hotels, cement industry, and textiles, which qualify under separate incentives.

Pioneer companies only.

If the employment objectives of industrialization in developing countries are indeed limited, it is pertinent to inquire why further attention should be given to an analysis of tax incentive measures to increase employment. Recognizing the limited scope for gains on this score, it may nevertheless be useful (1) to evaluate the employment-creating effects of existing schemes and (2) to explore techniques that may offer promise for future experimentation. In this analysis tax considerations are acknowledged to play a secondary role in the formation and expansion of industry in developing countries.6 Nevertheless, to the degree that tax incentives are effective they should be designed so as to realize the maximum development of a country’s resources, including labor supply. Underemployment of labor is one of the striking features of developing countries, and tax inducements for new investment that do not recognize this fact may fail to achieve optimum development.

With reference to the employment criterion, we shall attempt to evaluate the effectiveness of different incentive approaches relating to relief from both income taxes and customs duties. With regard to the former, these include (1) investment allowances and investment grants that are found in a number of developing countries, (2) tax holidays, which are in more general use, and (3) subsidies based on increases in employment or payrolls. In addition, (4) we shall examine the practice in some countries of levying taxes based on payrolls.

I. Customs Duties

Relief from customs duties and other taxes on imports of capital goods is an integral part of the investment incentive law of most countries. Since capital goods are not generally produced in developing countries, such exemption plays a key role in the strategy for development for import-substitute and export industries. Complete or partial exemption from duties on capital goods for new investment reduces financing requirements and enlarges the supply of real capital available from limited foreign and domestic sources. But whether tax neutrality as between the demand for capital and labor is best served by an exemption policy depends, inter alia, on the exchange rate. It may be argued that a tariff system leads to an exchange rate that is somewhat more appreciated than one that would prevail in the absence of import duties. If—as is generally true—capital equipment is favored by lower duties than those on most consumer goods, it may already enjoy a comparative exchange advantage that would be further enhanced by its exemption. And if a country’s currency is overvalued, there would be even less justification for lower duties on capital goods, especially if the wage-cost structure is inflated.

While most developing countries provide for partial or complete exemption from duties on supplies and materials that are not available domestically, this policy generally does not influence the capital/labor mix of new industries. Such exemption is typically combined with protective duties on the finished product and may have serious implications for national welfare, especially for assembly-type industries. For this reason, a necessary condition of the exemption should be some minimum amount of value added in domestic production.

II. Investment Allowances and Grants

In the provision of income tax incentives the central issue has revolved on the comparative merits of investment allowances (or grants) and tax holidays. Both are employed by developed and developing countries, although tax holidays are much more widely used. Each device can find support on economic and practical grounds, and each has its limitations. But it can be demonstrated on theoretical grounds that tax holidays are better suited to the economic conditions of developing countries.

Available information indicates that only about 11 developing countries provide investment and similar allowances, the principal provisions of which are summarized in Table 2.7 Of these, Korea provides a tax credit and Morocco a grant, which is available for investment outside Casablanca and Mohammedia. Investment allowances are concentrated in the members of the British Commonwealth located in East and Central Africa and in Ceylon and India. (Pakistan introduced a similar provision, at a 20 per cent rate, in 1962/63, but repealed it in 1963/64.) Only the provisions of Korea, Morocco, and Turkey appear to have had independent origins.

Table 2.

Selected Countries: Investment Allowances

article image

India also provides exemption from income tax on income not in excess of 6 per cent of capital investment.

With effect from April 1969, investment allowances superseded the two-year to four-year tax holidays that had been provided by the Pioneer Industry Act, 1965.

An investment allowance is a deduction from gross revenue, in addition to ordinary depreciation, that is based on a percentage of the cost of depreciable assets, including buildings, machinery, and equipment. Usually the amount is allowable in the first year and provision is made for a carry-over of any unused allowances to future taxable years. Only in Turkey does there appear to be an annual limitation on the amount that may be taken—20 per cent of taxable profits. Rates range from 10 per cent of investment in Malawi and Zambia to 50 per cent in Turkey, but typically are in the range of 15–20 per cent. It is not uncommon, however, to provide also for the acceleration of ordinary depreciation through high initial deductions in the first year, which permits a more rapid write-off of capital investment.

Investment grants are much less common than investment allowances. Although Morocco appears to have pioneered with this technique, in 1960, it is also employed in Canada and the United Kingdom.8 Whereas the tax benefit of an investment allowance depends on the realization of a taxable profit against which it can be offset, a grant is an outright subsidy that may be paid either as construction progresses or after completion of the project. It therefore holds a greater attraction than an investment allowance for the promotion of new ventures but may be more costly to the government.

We should not overlook another form of incentive for the expansion of an established business, which bears at least a family relationship to an investment allowance. This is the reinvestment allowance, which exempts from income tax all or part of corporate earnings that are retained and invested in approved projects.9 The tax benefit of such exemption is similar to that of an investment allowance at the effective income tax rate. Indeed, the benefit is more akin to a grant, since the earnings subject to tax otherwise would be paid to the government.

Tax benefits tied to the amount of investment serve a well-recognized purpose of lowering the threshold of business risk, which may present a barrier to new investment. By reducing the government’s claims to a share of earnings, they have the effect of enabling a business to recover its capital more quickly than under the normal provisions of income tax law. Investment allowances not only permit these claims to be reduced by the amount of the tax relief provided (i.e., the allowance times the tax rate) but also accelerate the capital recovery to the extent that the profitability of the enterprise permits. What is more relevant in the context of a developing country, however, is the fact that tax reductions geared to the amount of capital investment reduce the cost of capital in relationship to the cost of labor. The size of this differential depends on both the rate of the investment allowance and the tax rate. To take a typical case of a tax rate of 40 per cent and an investment allowance of 20 per cent, the reduction would amount to 8 per cent, assuming that the allowance is covered by earnings. At a 50 per cent tax rate and 25 per cent allowance, the reduction would be 12.5 per cent.

The main thrust of incentives based on investment allowances and grants therefore is the inducement of capital-intensive industries. Although this is the dominant characteristic of modern industry, it is not necessarily compatible with the best allocation of resources in a developing country where labor is in excess supply. For many manufacturing processes there is a range of ratios in which labor and capital may be combined, depending on their comparative supply and cost.10 To weight this balance by a tax incentive that favors capital may unduly encourage the substitution of capital for labor and prejudice greater employment of a country’s labor resources.

The capital substitution bias of investment allowances and similar provisions may, of course, be modified by implicit or explicit provisions that encourage employment of local labor. This may be accomplished in the administration of the plan by the establishment of minimum employment standards or by varying the investment allowance with labor intensity. For example, it is understood that South Africa gives special weight to employment in approving new grants, and awards higher allowances to ventures with high employment.

Canada’s Regional Development Incentives Act, which in 1969 superseded the Area Development Incentives Act of 1965, is unusual in providing a special bonus for labor in certain cases. It authorizes a primary development grant of up to 20 per cent of the approved capital cost of a new facility or expansion in a developing area. It also provides for a “secondary incentive” to assist in financing the cost of additional facilities for a product not previously manufactured in the plant; this consists of a grant of up to 5 per cent of the approved capital costs plus Can$5,000 for each new job created. Combined primary and secondary grants are limited to Can$30,000 per job, Can$ 12,000,000, or one half of the capital employed, whichever is the least.

If the basic principle of an investment allowance or grant is retained, consideration could be given to a formula that varies the percentage awarded with the capital/labor ratio of the project. The scale of the factors would have to be based on a study of capital/labor ratios for representative industries, and may be illustrated by the following scheme based on the investment per worker (in U. S. dollars):

article image

A minimum allowance of 5 per cent would retain the principle of the subsidy and would perhaps be applicable to such capital-intensive industries as oil refineries and cement mills. The higher allowances might be more relevant to such labor-intensive industries as agricultural processing, clothing manufacture, and assembly-type operations.

Various problems could be envisaged in the implementation of such a scheme. One of these is the measurement of employment. Since the ratio could be distorted by the use of part-time employees, employment would have to be based on equivalent full-time employment, i.e., man-years. Also, because employment follows on the completion of an investment and may not reach its planned level until some time later, a tentative allowance could be based on the experience during the tax year following completion of the investment, and adjusted during the succeeding two years.

Considerable doubt remains over the probable effect of such differential tax benefits on the capital/labor mix of new enterprises. Rather than materially influencing the labor intensity of a new business, i.e., its production function, they may have the effect of simply attracting more labor-intensive firms, generally small-scale businesses. The final result would depend on the elasticity of substitution of labor for capital, a matter on which there has been little, if any, empirical study in developing countries. Although the familiar Cobb-Douglas production function is assumed to have unity elasticity, and more recent studies based on cross-section analysis of selected manufacturing industries tend to confirm ratios approximating unity, the reliability of these estimates has recently been challenged by Lucas.11 Lucas’s estimates for the United States, based on time-series analysis, indicate an elasticity of substitution typically in the order of 0.3 to 0.5. It is conjectural how valid these ratios are for developing countries.

III. Tax Holidays

The tax incentive schemes of virtually all other developing countries are based on the partial or complete exemption of earnings for a definite period of time—known as a tax holiday. The tax holiday period typically is 5 years (e.g., Ivory Coast, Thailand) but may range to as many as 25 years (Togo). A description of the great variety of plans, including their coverage, qualifying conditions, and nature of tax benefits, is beyond the scope of this paper and may be found elsewhere.12 We are concerned more with the general principles of such tax exemptions and with their effects on employment.

In principle, a tax holiday is neutral as between capital and labor. In practice, however, investment laws are generally designed to attract capital investment rather than employment. Although the employment and training of native workers is usually a condition for the approval of a new enterprise, the size of employment generally is of less concern than the size of the investment. Many countries establish a minimum investment as a condition of approval and vary the holiday period with its size. In Nigeria, for example, the holiday period ranges from two years for a minimum capital investment of £N 5,000 to five years for capital of £N 50,000 or more; similar preferences are found in Malaysia, Singapore, and Togo. Other countries offer a longer exemption period to attract large-scale projects that may be important to economic development (e.g., Ghana, Liberia, Sierra Leone) and are usually of a more capital-intensive nature. The capital-incentive bias implicit in many of these acts is further illustrated by the provision for postponement of depreciation allowances until after the end of the holiday period, as in Ghana, Jamaica, Malaysia, and Trinidad and Tobago. This has the effect of enhancing the value of the tax exemption by the amount of the tax applicable to the depreciation that is deferred until after the holiday period.

Despite the capital-investment bias that is inherent in some investment laws and their administration, tax holidays clearly permit greater flexibility in adjusting the capital/labor proportions of a business to the conditions of supply in a developing country. If, as in most laws, the holiday period is not varied with the amount of investment, the size of the tax benefit depends on the profitability of the venture rather than on the amount of investment itself, as it would in an investment allowance.13 The holiday period, moreover, could be varied with the labor intensity of the business.

For these reasons, tax holidays are better adapted to the promotion of labor-intensive businesses without necessarily prejudicing their effectiveness for capital-intensive industries. Because of their neutrality they can be employed equally well for the attraction of either mechanized industries, or agricultural, agricultural-processing, and assembly-type industries, which are more dependent on labor. To better fulfill this role in a developing country it would be desirable to remove those features that discriminate in favor of capital, such as variation of the holiday period with the size of investment, and deferred depreciation. It should be recognized, however, that, unlike investment allowances, usually there is no ceiling on the tax benefit of tax holidays and they may involve greater revenue loss.

IV. Tax Incentives Based on Employment

When capital is scarce and labor is plentiful the right principle is to encourage the formation of businesses that are capital saving rather than labor saving.14 This should be done, if possible, in a way that increases the supply of capital but does not increase the demand for capital. If, because of a surplus labor situation, the primary objective of an industrial incentive program is to increase employment, it might be considered whether subsidies should be given to the employment of labor rather than of capital.

In the classical economic situation of an economy with surplus labor where land and capital are scarce, rates of profit and interest and the rent of land would rise and real wages would fall with the growth of the economy. Private entrepreneurs therefore would be induced to produce those things that required much labor and a minimum of land and capital; in producing goods and services they would choose those techniques in which the labor proportion is high.

In his case study of Mauritius, Meade has examined the implications of such a situation and analyzed alternative governmental approaches to the promotion of full employment that would assure a fair share to labor.15 If wages were set at a level that would give labor a reasonable share of the product, foreign capital might not be attracted, labor-intensive production would be discouraged, and unemployment would persist. Meade therefore considered several devices—including government ownership, redistribution of property, self-employment, cost of living subsidies, and subsidization of employment—that might help to solve the unemployment dilemma.

It is the last of these—employment subsidies—that I wish to consider. Within the context of an industrial incentive program such as we have been exploring, a subsidy for each employee, on an equivalent man-year basis, could be provided by the government. This could be limited to the new businesses that qualified under the investment incentive laws and could be extended as well to expansions of established businesses, as in Canada.

The size and character of the subsidy would have to be determined in the light of each country’s conditions and experience. A fixed annual amount per employee for a period of years, based on the level of unskilled wages, would appear to be the proper approach. A specific amount per employee would be better calculated to promote employment than a percentage of wages. It would also have greater administrative simplicity.

Much could be said for the adoption of a tax credit rather than a direct grant. Although a grant would have more appeal to business, it would be more costly to the government. As with an investment allowance, a tax credit would have a tax benefit only if the firm were profitable and declared taxable income. Moreover, unlike a grant, a tax credit would have to be administered by the revenue department, and the treasury would be in a better position to control it.

If developing countries are indeed faced by a problem of underemployment and scarcity of capital, how can a labor subsidy be justified? Wage rates should already be sufficiently low to encourage labor-intensive industries without the need for a bonus. Moreover, such a subsidy would hold little appeal for capital-intensive industries that may be needed to fulfill a country’s development objectives. These are questions that can be answered only in terms of each country’s economic structure and comparative advantage.

From the standpoint of attracting foreign investment, the general level of wages in a country is a matter that needs to be examined in terms of its relationship to wages in other countries. Not only should wage rates be taken into account but also the comparative efficiency of labor. Institutional factors and government minimum wage policies may hold absolute wages in a country at a level somewhat above that which could be expected from freely competitive conditions. Because of these rigidities, labor may tend to be overvalued relative to its marginal productivity, and maximum employment may be deterred. Under these conditions, a wage subsidy might be considered as an appropriate measure to promote fuller employment.

If such employment subsidies were authorized for only a temporary period, as for other tax incentives, what advantage would be gained? If they were grants, they would of course reduce the cost of labor inputs in the early stages of a business, which frequently is operated at a loss; if in the form of tax allowances or tax credits, by making more funds available for working capital and other purposes, they would help to sustain a business that succeeded in operating at a profit. To be effective, provision would have to be made for the carry-over of allowances or credits that could not be fully utilized in the early years because of inadequate profits. It might also be argued in support of short-term payroll subsidies that they serve to underwrite the cost of training labor in the early stages of promotion of a new enterprise. On the other hand, such subsidies could be continued indefinitely, or as long as they served their purpose.

When the limited scope for substitutability of labor for capital is considered, it is questionable if the expansibility of employment would be sufficiently great to warrant taking this route.16 And once a country has embarked on a program of this sort it would be difficult politically to keep the cost within a reasonable relationship to social benefits. As with existing tax incentives in many countries, it would be necessary to compensate for the revenue loss by tax measures that might have offsetting equity or economic effects.

If such employment incentives were substituted for existing tax benefits to promote new investment, there might be adverse effects on the supply of capital itself. This would be especially true for industries requiring large investment and whose factor proportions are dictated by modern technology. Unless special investment incentives were provided in the tax laws to ameliorate the risks of such capital-intensive industries (and perhaps others as well), a country might find itself at a disadvantage in attracting the foreign and domestic capital that is indispensable for economic growth.

V. Payroll Taxes

While no developing country appears to provide labor subsidies of the type described above, many do impose payroll taxes on employers for general fund purposes. Because these would seem to have adverse effects on the employment of labor, the desirability of their use in developing countries should be examined.

Such a payroll tax is distinguishable from employers’ contributions based on payrolls for the financing of social security in that its revenue usually is placed in the general fund rather than earmarked for employee benefit purposes. Virtually all these payroll taxes are modeled on the tax that was introduced by France in 1948 and went into effect on January 1, 1949.17 This was a tax of 5 per cent on all emoluments to labor, including benefits in kind, paid by employers; in 1956 it was graduated with the size of annual compensation to a maximum of 16 per cent. Finally, in December 1968, the tax was abolished for all employers subject to the value-added tax.

Similar taxes were introduced in Algeria and in the Francophone countries, before and after independence. In most of these countries the rate ranges from 2.5 per cent to 5.0 per cent of payrolls, the latter being the most common rate. The People’s Republic of the Congo and the Central African Republic impose a progressive rate of up to 8 per cent of payrolls. In addition to the Francophone countries of West Africa, payroll taxes are in effect in Burundi, Laos, Singapore, and Malaysia.

Except in Algeria, where the tax accounts for about 8 per cent of government revenue, such payroll taxes contribute relatively little revenue. Available data for ten African countries listed in Table 3 show an average of 1.3 per cent of total revenue and 6.4 per cent of direct tax revenue. These low ratios may be explained partly by the fact that indirect taxes account for the preponderance of revenue in developing countries, and partly by the fact that the monetary sector is limited and wage payments are a relatively small part of the national product. It is significant, however, that in a few countries (e.g., Chad) payroll tax receipts are almost as important as income taxes on corporations.

Table 3.

Selected Countries: Payroll Tax Rates on Industrial Employers

(In per cent)

article image
Sources: Tax statutes; U. S. Department of Health, Education, and Welfare, Social Security Programs Throughout the World, 1969.

Where applicable, includes payroll taxes for the financing of old age, invalidism, and death; sickness and maternity; work injury; and family allowances.

The burden of payroll taxes on employers that we have been considering cannot be viewed in isolation but must be appraised in conjunction with all other levies on payrolls. In addition to social security taxes, they include others, such as the French apprenticeship tax (taxe d’apprentissage), which is levied in many Francophone countries to finance the training of workers. This ranges between 0.3 per cent and 2.0 per cent of payrolls, the most common rate being 0.5 per cent. Of greater importance are the separate contributions imposed on employers, the receipts from which are earmarked to finance old-age pensions, health benefits, occupational hazards, and family allowances. While they frequently are limited to monthly payrolls below a certain maximum, these are within the limits of unskilled and semiskilled wages.

The cumulative effect of these taxes on payrolls is shown by the data presented in Table 3. (These figures do not include taxes withheld by employers from employees.) For countries that also have general fund payroll taxes, the combined rates range to 25.75 per cent in Algeria and 25.2 per cent in Guinea. High as these rates are, they are surpassed by social security taxes in effect in Bolivia (28.0 per cent) and Chile (36.5 per cent to 41.8 per cent).

It is beyond the scope of this paper to evaluate the financing of social security. This matter has been treated elsewhere by others, including the International Labour Office.18 But the level of payroll tax rates in many developing countries has been pushed to the point where a serious bias may be created for the substitution of capital. If this is true, it is difficult to justify the further imposition of taxes on payrolls to finance general governmental expenditures.

The effect of a payroll tax on the allocation of capital and labor depends on whether its incidence is on the employer or on labor. If as a result of a shifting process wages are less than they otherwise would be by the amount of the tax on employers, there would be no incentive to substitute capital for labor. According to the classical view, wages are determined by the value of the marginal product of labor; since the cost of labor includes the payroll tax, it tends to be shifted to the employee in lower wages. This position recently has been supported by impressive empirical evidence. Based on a cross-section analysis of wages and payroll taxes paid in a large number of countries, Brittain has demonstrated that, at a given level of labor productivity, a payroll tax on employers tends to reduce wages by roughly the amount of the tax.19

If, indeed, the incidence of payroll taxes is on the wage earner, it may be induced in part by the substitution of capital that reduces the demand for labor. The shifting process itself may be inhibited by minimum wage laws and institutional factors in the labor market. As a result, there may be adverse effects on employment.20

VI. Summary and Conclusions

The experience of developing countries provides little support for the belief that tax incentives can be an effective instrument for the creation of employment in industry. Taxation is greatly overshadowed by other economic and political considerations in the attraction of new industry, and at best tax incentives only marginally influence the investment decision. Tax benefits would have even less leverage in inducing the substitution of labor for capital in many industries where factor proportions are fixed by technology. Within limits, however, there may be some scope in the use of appropriate tax measures for enhancing the labor/capital ratio and encouraging labor-intensive industries.

Investment incentives based on investment allowances or grants tend to lower the price of capital as against labor. While such new investment entails additional employment (if not accompanied by a loss of jobs in traditional industries), the amount of capital tends to be increased at the cost of employment. This bias could be redressed in part by a system that varies the investment allowance with the capital/labor ratio. One objection to this policy may be the danger of losing industries with high capital/labor ratios—such as oil refineries and cement mills—which may find inadequate compensation in the capital allowances for their high investment risk.

Tax holidays are better adapted to the conditions of capital scarcity and labor surplus that characterize developing countries. Since the tax benefit is measured by the size of profits rather than by either investment or wages, tax exemption is neutral as between capital and labor. The proportions therefore can be better adapted to the comparative supply conditions and costs in a developing country. However, both the tax holiday law and its administration in many countries tend to favor capital investment rather than employment. Removal of these biases would have some beneficial effects for employment.

Tax incentives based on increases in employment may find some justification under conditions of labor surplus. These could take the form of a labor allowance or grant based on the number employed in a new business or expansion. Subsidization of wages, however, may appear to be redundant in a situation of high unemployment and low wages where conditions already are favorable for labor-intensive industries. But if institutional and legal conditions sustain wages at an artificially high level, an employment subsidy might be considered. However, the cost of financing such benefits should be weighed against the limited social benefits that are likely to be achieved. Moreover, this approach could not be undertaken to the exclusion of investment incentives that may be necessary to attract certain capital-intensive industries.

The capital-intensity effects of investment incentives are frequently compounded by heavy payroll taxes on employers. Although payroll taxes that are earmarked to finance social security benefits may be justified, within limits, many countries have also resorted to payroll taxes for general budget purposes. The cumulative rates of these taxes in some countries tend to place a high price on the employment of labor and thereby encourage the substitution of capital. To the degree that such taxes are not shifted to employees, this tax policy is incompatible with the optimum allocation of resources in a developing country.

Stimulants fiscaux en vue de l’accroissement de l’emploi industriel dans les pays en voie de développement


L’expérience des pays en voie de développement ne corrobore guère la croyance dans l’efficacité des stimulants fiscaux comme instruments d’une politique d’accroissement de l’emploi. Cela ne veut pas dire que l’application judicieuse de certaines mesures fiscales ne puisse pas avoir une utilité, fût-elle limitée, pour Amelioration du rapport main-d’œuvre/capital et pour l’encouragement d’industries qui ont recours a une forte proportion de main-d’œuvre.

Les encouragements à l’investissement par voie d’abattements ou de subsides tendent à faire baisser le prix du capital par rapport à celui de la main-d’æuvre. Bien sûr, ces nouveaux investissements donnent lieu à une augmentation de l’emploi (s’ils n’entraînent pas une diminution de celui-ci dans les industries traditionnelles). Néanmoins, le capital tend à s’accroître aux dépens de l’emploi. Le déséquilibre peut être redressé en partie par un système qui gradue les abattements pour investissement d’après le rapport capital/main-d’æuvre. On pourrait pourtant objecter qu’avec ce système un pays s’expose à perdre des industries ayant un rapport capital/main-d’ceuvre élevé parce qu’elles trouveraient dans ces dégrèvements une compensation insuffisante des gros risques que comportent leurs investissements.

A l’effet normal des stimulants à l’investissement, c’est-à-dire l’augmentation de la teneur en capital, s’ajoute souvent celui des taxes sur les salaires imposées aux employeurs. Les taux cumulatifs de ces taxes dans certains pays contribuent à renchérir considérablement la main-d’æuvre et encouragent ainsi les employeurs à la remplacer par du capital.

Les exonérations temporaires d’impôts sont mieux adaptées aux conditions de pénurie de capitaux et d’abondance de main-d’ceuvre qui caractérisent les pays en voie de développement. Comme le dégrèvement est fonction des bénéfices et non des investissements ou des salaires, l’exonération ne favorise ni le capital ni la main-d’ceuvre. II est done possible de mieux adapter la proportion entre ces deux éléments aux conditions respectives des disponibilités et des coûts dans les pays en voie de développement. Quoi qu’il en soit, les lois d’exonération temporaire et la façon dont elles sont appliquées dans bien des pays tendent à favoriser les capitaux d’investissement plutôt que l’emploi.

Des stimulants fiscaux liés à l’augmentation de l’emploi peuvent se justifier en cas d’excédent de main-d’æuvre. lis peuvent prendre la forme d’abattements ou de subsides basés sur le nombre de personnes employées dans une entreprise nouvelle ou nouvellement agrandie. Si les conditions structurelles et légales maintiennent les salaires à un niveau artificiellement élevé, l’octroi de subventions à l’emploi peut être pris en considération. II faudra cependant peser le coût de leur financement en fonction du caractère probablement limité des avantages sociaux qui en découleraient.

Incentivos tributarios para la promoción del empleo en las industrias de los países en desarrollo


La experiencia de los países en desarrollo apoya muy poco la opinión de que los incentivos tributarios pueden constituir un instrumento eficaz para lograr grandes aumentos del empleo en las industrias. No obstante, dentro de ciertos límites, el uso de medidas tributarias adecuadas puede prestarse para acrecentar la relación mano de obra/capital y fomentar las industrias que requieren una alta densidad de mano de obra.

Los incentivos basados en desgravaciones o subvenciones por inversión tienden a reducir el costo del capital en comparación con el de la mano de obra. Si bien las nuevas inversiones resultantes dan origen a nuevas fuentes de empleo (siempre que no vayan acompañadas de la supresión de empleos en las industrias tradicionales) existe la tendencia a aumentar la cantidad de capital a expensas del empleo. Esta tendencia puede corregirse en parte con un sistema que haga que el porcentaje de desgravación varíe según la relación capital/mano de obra. Un inconveniente de esta política puede ser el peligro de que desaparezcan las industrias con una relación capital/mano de obra elevada, dado que éstas pueden considerar que dichas desgravaciones no alcanzan a compensar el gran riesgo de inversión que asumen.

A la intensification del uso de capital provocada por los incentivos tributarios, frecuentemente vienen a sumarse los onerosos impuestos que recaen sobre las planillas de sueldos de las empresas. En algunos países, las tasas acumulativas de estos impuestos tienden a elevar considerablemente el costo del empleo de mano de obra y, por ende, a favorecer el capital en perjuicio de la mano de obra.

Las exoneraciones temporales de impuestos se adaptan mejor a situaciones en que escasea el capital y abunda la mano de obra, como las que caracterizan a los países en desarrollo. Puesto que el beneficio tributario se calcula en relación con la magnitud de las utilidades y no de la inversión o de los salarios, dichas exoneraciones son neutrales con respecto al capital y al trabajo. De modo que su proporción puede adaptarse mejor a las condiciones relativas de la oferta y de los costos en los países en desarrollo. Sin embargo, en muchos países, tanto la ley de exoneraciones tributarias temporales como su administración favorecen a la inversión de capital, más bien que al empleo.

Los incentivos tributarios que se basan en el aumento de empleos pueden justificarse cuando existe excedente de mano de obra, y podrían adquirir la forma de desgravaciones o subvenciones basadas en el número de personas empleadas en las empresas nuevas o ampliadas. Si las características institucionales y jurídicas hacen que los salarios se mantengan a un nivel artificialmente alto, podría considerarse la adop ción de subsidios para favorecer el empleo. En todo caso es preciso comparar el costo del financiamiento de dichos beneficios con las limitadas ventajas sociales que probablemente se lograrían.


Mr. Lent, Assistant Director, Fiscal Affairs Department, formerly served as assistant director of the tax analysis staff, U. S. Treasury Department; consultant, Organization of American States; and research associate, National Bureau of Economic Research. He has been on the faculty of the University of North Carolina and Dartmouth College.


This article is based on a paper prepared for the International Labour Office Meeting of Experts on Fiscal Policies for Employment Promotion, Geneva, Switzerland, January 4–8, 1971.


Among the more general works are the following: Jack Heller and Kenneth M. Kauffman, Tax Incentives for Industry in Less Developed Countries (Harvard Law School, 1963); Johannes R. Kahabka, Tax Incentives for Private Industrial Investment in Less Developed Countries, Report No. EC-102, International Bank for Reconstruction and Development (mimeographed, Washington, 1962); George E. Lent, “Tax Incentives for Investment in Developing Countries,” Staff Papers, Vol. XIV (1967), pp. 249–323; Pedro Mendive, “Tax Incentives in Latin America,” United Nations, Economic Commission for Latin America, Economic Bulletin for Latin America, Vol. IX (1964), pp. 103–16; Organization for Economic Cooperation and Development, Fiscal Committee, Fiscal Incentives for Private Investment in Developing Countries (Paris, 1965); Alan R. Prest, “Taxes, Subsidies and Investment Incentives,” in Government Finance and Economic Development, ed. by Alan T. Peacock and Gerald Hauser, Organization for Economic Cooperation and Development (Paris, 1965), pp. 113–26; United Nations, Department of Economic and Social Affairs, Foreign Investment in Developing Countries (Sales No. E.68.II.D.2, New York, 1968); United Nations, Economic Commission for Africa, Investment Laws and Regulations in Africa (Sale No. 65.II.K.3, New York, 1965); United Nations Industrial Development Organization, Tax Incentives for Industrial Development (mimeographed, ID/Conf.l/B.2, May 2, 1967).


Richard M. Bird, Taxation and Development: Lessons from Colombian Experience (Harvard University Press, 1970), pp. 124–25.


Gunnar Myrdal, Asian Drama, Vol. II (New York, 1968), pp. 1202–203.


For a good survey of the dimensions of the problem, see David Turnham and Ingelies Jaeger, The Employment Problem in Less Developed Countries: A Review of Evidence, Organization for Economic Cooperation and Development, Development Centre (Paris, June 1970).


See George E. Lent, “Tax Incentives in Developing Countries,” Rivista di Diritto Finanziario e Scienza delle Finanze (March 1970), pp. 11–12.


Investment allowances are to be found in several European countries. In 1962 the United States adopted a 7 per cent investment tax credit, a variant of the tax allowance, but this was rescinded in 1969.


On October 27, 1970 the U. K. Government announced the discontinuance of the grant program after October 26 and its replacement in development areas by free depreciation. Net annual savings were estimated at about £200 million. (Investment Incentives, Cmnd. 4516, London, October 1970.)


Among the developing countries providing for full or partial tax exemption of reinvested earnings are Brazil, Chad, Colombia, Costa Rica, China, Ecuador, Guatemala, Honduras, Nicaragua, Morocco, Peru, Senegal, Somalia, Tunisia, and Uruguay.


This is especially true of agricultural-processing industries. For example, a machine for the processing of tobacco leaf may be less economical than hand processing when there is an abundance of cheap, unskilled labor. Similar economies may be realized in the handling of materials.


Robert E. Lucas, Jr., “Labor-Capital Substitution in U. S. Manufacturing,” in The Taxation of Income from Capital, ed. by Arnold C. Harberger and Martin J. Bailey, The Brookings Institution (Washington, 1969), pp. 223–74.


See, for example, Lent, “Tax Incentives for Investment in Developing Countries” (cited in footnote 6); Economic Commission for Africa, Investment Laws and Regulations in Africa (cited in footnote 1).


The realization of profits is, of course, a necessary condition for a tax benefit under an investment allowance.


A.R. Prest, A Fiscal Survey of the British Caribbean, Colonial Research Studies, No. 23 (London, 1957), p. 27; J.E. Meade, “Mauritius: A Case Study in Malthusian Economics,” The Economic Journal, Vol. LXXI (1961), pp. 521–34.




For these reasons, Papanek has seriously questioned the potential effectiveness of various labor subsidies proposed for Pakistan. In his opinion, “If a subsidy were to increase industrial employment by 10 percent, this would hardly affect the large number of unemployed and underemployed.” Gustav F. Papanek, Pakistan’s Development: Social Goals and Private Incentives (Harvard University Press, 1967), p. 249.


Called the versement forfaitaire sur les salaires à la charge des employeurs, it was enacted at the time of the repeal of the 15 per cent schedular tax on employees that was withheld by employers, partially in compensation for the revenue loss.


For an excellent review and references to the literature, see Franco Reviglio, “The Social Security Sector and Its Financing in Developing Countries,” Staff Papers, Vol. XIV (1967), pp. 500–40.


John A. Brittain, “The Real Rate of Interest on Lifetime Contributions Toward Retirement Under Social Security,” in Old Age Income Assurance, Part 111: Public Programs (a compendium of papers on problems and policy issues in the public and private pension system submitted to the Subcommittee on Fiscal Policy of the Joint Economic Committee, 90th Congress, 1st Session, Washington, 1967), pp. 112–14. (Also issued by The Brookings Institution as Reprint 143.) Brittain has elaborated on the methodology and theoretical basis for his findings in “The Incidence of Social Security Payroll Taxes,” The American Economic Review, Vol. LXI (March 1971), pp. 110–25. The regression analysis was based on 1958 census data for 30 to 64 countries, including developing countries.


Shoup holds that a labor-income tax cannot drive producers to more capital-intensive methods or to modernize their methods of production unless the tax also reduces the rate of interest or rate of profit. This is so because an increase in labor costs forces an equal percentage increase in the cost of machinery. He concedes, however, that some substitution may occur in an open economy since a domestic payroll tax will not raise the cost of producing capital equipment imported from abroad. Carl S. Shoup, Public Finance (Chicago, 1969), pp. 412–13. See also Paul A. Samuelson, “A New Theorem on Nonsubstitution,” The Collected Scientific Papers of Paul A. Samuelson, Vol. 1 (The M.I.T. Press, 1965), pp. 520–35.